Banks On The Long And Winding Road To Recovery

The Banks Embark On The Long And Winding Road To Recovery

New Zealand’s five major banks (ANZ National, ASB, BNZ, Kiwibank and Westpac) have weathered recent turbulent times caused by the global financial crisis, our domestic recession, and have put the settling of the conduit tax disputes behind themselves to record respectable, if unspectacular, profits for the first six months of their 2010 financial year (1H10). The banks are emerging from the post- Global Financial Crisis (GFC) turbulence healthy enough, but probably still feeling a little deflated.

According to PricewaterhouseCoopers’ latest edition of New Zealand Banking Perspectives, an analysis of the five majors’ financial performance, the banks’ most recent combined half-year statutory profits for 1H10 amounted to $1.3 billion, a virtual mirror image of their combined statutory loss of $1.4 billion for six months earlier. However, compared to the same period last year, there has only been a 3 percent or $39 million increase in statutory profits, but at a pre-tax level, the earnings are down $287 million or 15 percent.

PwC Financial Services Partner Sam Shuttleworth says “While the headline profits report an impressive turn around by the banks over the last six months, it is important to look at the contributors to this recent result as the underlying position has not improved as dramatically as it may first appear. Core earnings are up $483 million or 25.2 percent, largely on the back of favourable mark-to-market movements on derivative instruments. Also, bad debts expenses have eased on the back of lower corporate sector write-offs and the reversal of the conduit tax disputes provisioning following the agreed settlement also favourably contributed to the reported results,” Mr Shuttleworth adds. “It is evident the banks are back, but are still below the levels that we saw before the GFC.”

While the road ahead looks relatively flat for the banks, there remains the potential for a few pot holes to disrupt their journey along the way. However, the banks seemed to be well positioned to return to what might be considered 'normal' levels of profitability and activity. So, we are probably seeing the commencement of a long and winding road to recovery.

Net interest income remains flat and fees have lowered
Focusing specifically on net interest income by the majors in 1H10, this is marginally down, by $10 million or less than one-third of one percent. While the banks have experienced a continuation of higher funding costs due to the competitive retail deposits market and as they began to bring tenor into their wholesale funding books, it is evident that at least some of the banks have been able to pass these costs onto their customers through increases to their reported net interest margins. This was a turn-around from the previous six months.

Mr Shuttleworth says “Looking forward, we would not expect the pressure on funding costs to diminish given the banks’ needs to prudently manage their liquidity and regulatory requirements. As a result, upwards pricing pressure on lending will remain as the higher funding costs are passed on and the recently low net interest margins return to historical levels pre the credit boom.”

Putting aside the mark-to-market movements on derivative instruments that formed the bulk of the increase in other income for the period, we also witnessed a reduction in fees charged to customers as the banks revisited their fee arrangements and experienced lower fees generated from reduced lending volumes.

Bad debts decline
Bad debt expenses for 1H10 reduced to $768 million, a decrease of $498 million from the amount in the previous six months. The major improvement was witnessed in the corporate sector, with bad debt expenses down by $491 million to $315 million, reflective of the large amount of the pain that was taken in 2009.

Mr Shuttleworth says “What is surprising though, is bad debt write-offs to the household sector were only down $7 million to $453 million when compared to the previous six months. This indicates the fundamentals of the two lending classes differ, with the household sector lagging the corporate sector from an impairment/recovery perspective. It is not evident the deterioration in household sector loans has halted yet but unless the global and domestic economies perform adversely against expectations, we have probably experienced the worst of the corporate sector write-offs in New Zealand.”

Lending and funding
Bank lending remained static, up only $0.1 billion to $277.2 billion at the end of 1H10. Household lending was up 3% but was largely offset by a contraction in corporate lending. While the banks appear to be back in business to lend, we cannot see any major reversal of this trend in the near term given the upwards re-pricing for risk which has occurred, especially in the corporate sector. The latter is likely to be putting many companies off increasing their current bank borrowings to fund discretionary opportunities given bank funding has become relatively more expensive than before.

Mr Shuttleworth adds “The banks have further strengthened their funding tenor over the last six months and have continued to attract further retail funding. While the banks have focused on term wholesale funding, that funding is vulnerable to external influences (i.e. developments in the Northern Hemisphere) and the focus on alternative funding mechanisms should remain a priority.”

Note to the Editors:
This paper takes a look at the recent results of the four major Australian-owned banks that operate in New Zealand – Westpac (including Westpac New Zealand Limited), CBA (including ASB Bank), ANZ (including ANZ National Bank) and BNZ, as well as Kiwibank.

Kiwibank has been included because although it is smaller in size than the four majors, it has had a high profile impact on the local market.
The report covers the reported results for the first and second halves of the banks’ respective 2009 financial years (1H09 and 2H09 respectively), and the first half of the 2010 financial year (1H10). The report is based on information publicly available as at 24 August, 2010.

PricewaterhouseCoopers’ New Zealand Perspectives Major Banks Analysis is available at http://www.pwc.com/nz/banking-perpectives on 10 September, 2010. The most recent PricewaterhouseCoopers Australia Perspectives publication, which analyses the four major Australian Banks, is available at
http://www.pwc.com.au/industry/banking-capital-markets/publications/major-banks-analysis/index.htm
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